The $17 Contract and the $2,000 Mold
A small manufacturer sells a single product at $25 per unit. Fixed costs are $18,000 a month, and variable cost is $13 per unit. Current volume is 1,600 units a month. Plant capacity is 1,800 units a month on straight time; any unit above 1,800 costs an extra $4 in overtime premium, and overtime can cover at most 400 units. A new distributor, who does not compete with any existing customer, offers to buy 500 units a month at $17 each for a one-year term, but the units must be built to a new spec that requires a $2,000 mold, charged in the first month only, and the mold has no resale value.
1. Compute monthly break-even volume and current monthly profit.
Read the worked answer
Contribution margin per unit: $25 − $13 = $12.
Break-even volume: $18,000 / $12 = 1,500 units per month.
Current profit: 1,600 × $12 − $18,000 = $19,200 − $18,000 = $1,200 per month.
Worth noting before evaluating the offer: the company is running at 1,600 of 1,800 units (89% utilization) with only $200 of cushion above break-even, so 100 units of lost volume would wipe out the month's profit. That sensitivity frames how the offer should be judged - it is not a rich company turning away easy money.
2. Should the company accept the 500-unit order at $17? Show the full contribution, the mold, and the overtime effect.
Read the worked answer
Step 1 - contribution on the order: $17 − $13 = $4/unit × 500 = $2,000.
Step 2 - mold: $2,000 one-time, no resale. Net so far: $2,000 − $2,000 = $0.
Step 3 - capacity, which is where the deal turns negative:
- New volume = 1,600 + 500 = 2,100 units, or 300 above the 1,800 straight-time ceiling.
- Overtime premium = 300 × $4 = $1,200.
- 300 ≤ the 400-unit overtime limit, so it is feasible - just costly.
Net effect: $2,000 − $2,000 − $1,200 = −$1,200 in the first month, and $2,000 − $1,200 = +$800 per month thereafter, once the mold is amortized in full. Over the 12-month term the deal nets roughly $800 × 11 − $1,200 = +$7,600.
The judgement call: the deal is not simply "reject, it loses money." It loses money in month one and pays thereafter - the answer depends on whether the distributor really stays for the full term. If the company cannot enforce the term, rejecting is defensible. If it can, accepting requires acknowledging a first-month loss to reach a modest full-year gain.
3. What minimum price per unit makes the 500-unit order break even on a full-year basis, including the mold and the overtime premium? Assume the mold is charged once and the order runs 12 months.
Read the worked answer
Set up the annual equation. Total extra costs over the term are the mold plus the overtime premium, both incurred while the order runs:
Annual extra cost to serve the order:
- Mold: $2,000 (one time)
- Overtime: $1,200/month × 12 = $14,400
- Total: $16,400
Required annual contribution: 500 units × 12 months = 6,000 units, so contribution per unit must be $16,400 / 6,000 = $2.7333.
Minimum price: $13 variable cost + $2.7333 = $15.73 per unit.
So the $17 offer clears the annual hurdle with margin to spare (roughly $1.27/unit, about $7,600 a year), even though it fails in month one. The reason to quote the annual figure rather than the monthly one is that the mold is a one-time cost; pricing the deal against a single month's $1,200 loss would overstate the required price by several dollars a unit and likely lose the order.